Context Matters: FHA’s Latest Actuarial Review

Context Matters: FHA’s Latest Actuarial Review

Erika Poethig, Acting Assistant Secretary for Policy Development and ResearchAs noted in our November housing scorecard, we are beginning to see encouraging signs of a housing market recovery. In 2012, housing construction grew faster than at any time since 2008; it was the strongest year of home sales since the economic crisis began; and rising home values lifted more than 1.3 million families above water. The Federal Housing Administration (FHA) has been critical to the housing market recovery by helping fill in gaps in the market, being a source of capital for underrepresented borrowers, and acting as a stabilizing force during the economic recession.

While FHA has acted as a critical support, it was not immune to the stresses of falling home values and the unemployment rate at the height of the worst economic recession in a generation. FHA made headlines on November 16 when it released its FY 2012 actuarial review. This annual report showed that the capital reserve ratio of the Mutual Mortgage Insurance (MMI) Fund, the principal insurance fund backing FHA’s single family mortgage programs, has fallen below zero, to negative 1.44 percent.

What exactly does this statistic mean, and what are its implications for the FHA and its MMI Fund? As Secretary Donovan explained in his recent testimony before the Senate Banking Committee, the actuarial review measures the economic net worth of FHA’s portfolio, i.e., the total value of the portfolio after FHA pays all expected claims for the next thirty years under a hypothetical scenario where no new loans are insured. The FHA’s economic net worth is then divided by the total value of the MMI Fund’s insurance in force to reach an estimated capital reserve ratio for the Fund. Although the actuary’s finding regarding the current value of the Fund is cause for concern, it does not mean the FHA has insufficient funds to pay insurance claims, nor does it determine whether the FHA will need to exercise its authority to draw funds from the Treasury. A decision regarding whether such a draw is necessary will not be made until the end of FY 2013 in accordance with federal budgeting processes. In the intervening period, the President’s FY 2014 budget will detail whether the Administration anticipates that FHA will require assistance by the end of the fiscal year. However, the performance of the FHA single family program throughout the year, as well as the efficacy of FHA’s efforts to increase revenue and reduce losses, will ultimately determine whether FHA needs assistance.

As we reflect on the actuarial review, a new PD&R working paper on the FHA single family program provides a number of insights on these issues. First, FHA has successfully weathered similar challenges in the past. For instance, the first ever independent actuarial review of the MMI Fund (in 1989) found that FHA was solvent but not actuarially sound, as the study showed that the fund was critically low on reserves and would continue to lose money absent reforms. Faced with these results, Congress and President George H.W. Bush together enacted a number of reforms designed to restore the MMI Fund to actuarial soundness while fulfilling the public purpose of the FHA. Key among these was the Cranston-Gonzales National Affordable Housing Act (NAHA) of 1990, which included a new actuarial soundness target to be achieved by FY 2000. Because the FHA had been underpricing its insurance for over a decade, the NAHA reforms took time to rebuild the Fund’s capital reserve, which dipped below zero in FY 1990 and FY 1991. But the reforms did turn FHA’s finances around, and the Fund achieved its new actuarial soundness target by FY 1995 – five years before the NAHA requirement became effective. Incidentally, the NAHA actuarial soundness target for FHA requires it to maintain a minimum level of capital of 2.0 percent of insurance in force (or aggregate balance) on FHA’s loan portfolio. Historical record shows that this target was designed to enable FHA to maintain positive capital through only a moderate recession, not a severe downturn like that experienced in recent years.

Second, the paper provides a detailed overview of the role played by FHA in the nation’s mortgage finance market since its inception in 1934. Over the years, FHA has helped stabilize housing markets, set market standards, provide information on mortgage performance to the marketplace, and address market failures such as credit rationing. In so doing, FHA has expanded opportunities for credit-worthy low-wealth (often newly formed) households and allowed them to achieve affordable, sustainable homeownership. FHA has also played a vital counter-cyclical role in keeping credit flowing during periods of economic stress and corresponding private lending constriction. Some experts posit that FHA’s support prevented the collapse of the entire housing market and a far deeper economic recession. But as the broader debate over the future of the government’s role in housing finance unfolds, key questions remain. The paper is intended to provide the current and historical context needed to address immediate and emerging issues thoughtfully.

There is no doubt that policymakers must grapple with difficult trade-offs in setting new policies. Through its evidence-based research, PD&R aims to inform the debate about these trade-offs and thereby enable effective policymaking. Our next issue of Evidence Matters will highlight research that measures the effectiveness of different strategies for providing sustainable homeownership for low and moderate-income households. So stay tuned!

On a personal note, I will be taking a break from this commentary in The Edge. Later this month, I will be taking maternity leave through the end of March. During my absence, PD&R’s senior leadership team will share their thoughts and perspective in this column on a wide range of issues and research that cover PD&R’s portfolio. I know you will enjoy hearing from some new voices.

I wish you all a peaceful and joyous holiday season. All the best for 2013.